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Europe real estate outlook: three predictions for 2019

A number of factors threaten demand for European real estate in 2019, not least Brexit, trade tensions and rising interest rates. However, there are some optimistic signs. Brexit talks and the US-China trade dispute could still be resolved satisfactorily. And interest rate rises will be, for the most part, gradual, which should result in continued demand for real estate assets from institutional investors. Appropriate strategies will be needed to mitigate late-cycle risks.

Against this backdrop, here are our three predictions for property markets in continental Europe in 2019, covering the key risks and opportunities.

1. We are at a late stage of the cycle…

With global monetary policy now set to tighten, the search for yield is easing somewhat – although it should be noted that property will still offer an attractive risk premium over the medium term. For example, the yield on German 10-year Bunds is expected to rise to just 1.6 per cent by the end of 2021, compared with an average of 4.3 per cent between 2000 and 2007 (see figure 1). While flows into riskier, less-established parts of the real assets universe may start to slow, prime property assets in locations supported by favourable economic conditions will remain in demand and are less likely to experience significant repricing.

Moderation in returns is expected from next year. We forecast an average annualised return of 3.1 per cent across prime European commercial real estate markets between 2019 and 2023, against an expected average return of 14.2 per cent between 2014 and 2018.

Compared to the previous cycle, we believe there are reasons to be optimistic as the risks around supply and leverage are relatively weak compared to the previous peak. Furthermore, the European economy and occupier markets are expected to remain strong.

2. …which requires an appropriate strategy

At this stage in the cycle, real estate investors in Europe are relatively poorly compensated for taking on extra risk. Positioning defensively is the most appropriate course of action. To enhance income-producing strategies, investors should look at opportunities to improve or create income growth by actively managing, repositioning and developing assets in strong locations.

Another way to play against the cycle is to look for opportunities where thematic factors are supportive. In other words, long-term structural drivers of real estate that are likely to provide opportunities include technological change, automation, shift in consumer preferences and demographics.

As direct investments become more expensive in some markets, the case for real estate debt and real estate investment trusts (REITs) is becoming more compelling in Europe. Investors in real estate debt can expect to receive income and – provided capital is sensibly lent – little capital value risk.

REITs also continue to offer good value. European REITs traded at an average discount of 10.3 per cent to net asset value in the third quarter. On this basis, REITs should offer a better entry point than direct investments next year if they remain expensive.

3. European sub-markets may offer positive risk-adjusted returns

As the macroeconomic backdrop becomes more challenging, investors are advised to focus on local drivers of demand. In Europe, emerging sub-markets in urban centres may offer a way of taking some risk to create value; fast-growing sub-markets can display significant growth and outperformance compared with the wider market, especially if they stand to benefit from urban planning or infrastructure development projects.

A good example is the Grand Paris infrastructure development, which is improving transport links and promoting development in areas on the outskirts of the French capital.

Authors

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (Aviva Investors) as at December 9, 2018. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this document, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This document is not a recommendation to sell or purchase any investment. In the UK & Europe this document has been prepared and issued by Aviva Investors Global Services Limited, registered in England No.1151805. Registered Office: St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Telephone calls to Aviva Investors may be recorded for training or monitoring purposes. In Singapore, this document is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited for distribution to institutional investors only. Please note that Aviva Investors Asia Pte. Limited does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia Pte. Limited in respect of any matters arising from, or in connection with, this document. Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583.In Australia, this document is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd for distribution to wholesale investors only. Please note that Aviva Investors Pacific Pty Ltd does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Pacific Pty Ltd in respect of any matters arising from, or in connection with, this document. Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000

The name “Aviva Investors” as used in this presentation refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606

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